The more you make, the more you spend

I’ve got several friends (I was once this person too) who seem to rely on future earnings to bail them out of their current financial situation, and it’s certainly the wrong way to think for various reasons.

I hear this quite often from this type of person - “If I only made more money everything would be alright.” The problem is, this won’t help them get out of the trouble they’ve got themselves into, in fact, it may just make it worse. That’s because, the more they make, the more they spend. Quite often, they’ve spent the money they will make before they’ve even made it. They never develop a true plan for controlling their spending while eliminating their debt and planning for the future.

In the personal finance world, there are typically two kinds of people; Balance Sheet rich or Income Statement Rich. Think of your balance sheet as a snapshot of your net worth, that is everything you own, less what you owe. For example, your home is worth $200,000, but you owe $175,000, if you owned nothing else or owed nothing else, your net worth (or owner’s equity) would be $25,000 ($200,000 – 175,000 =$25,000). Think of your income statement as your revenue less expenses, or your income less your expenses.If you bring in $3,000 per month and you spend $3,000 per month, you’ll have nothing left over at the end of the month, and you’re simply meeting your bills.

Let’s look at two people and discuss who’s balance sheet rich or income statement rich. Fred makes $30,000 per year and owns a home valued at $100,000, but he owes $30,000 on the home still. He also owns his two vehicles free and clear and has no credit card debt. He has also built a retirement nest egg of $250,000. Bill on the other hand makes $150,000 per year, owns a home valued at 1,000,000 – but he owes $950,000 on the home, and has two vehicles he’s making payments on, along with credit card bills, boat payments and much more. At the end of the month, Fred hasn’t a dime to put away for retirement and he finances anything he needs through credit card purchases.

Fred is balance sheet rich, while Bill is income statement rich. Fred will be better off in the long run even though he makes only a 5th of what Bill does. Bill lives modestly and is not burdened by debt and its associated problems. Fred on the other hand, makes good money at his job, but still, at the end of the month, he’s broke and is hardly accumulating any net worth (assets minus liabilities). In fact, he’s just going deeper into debt with no real hope of accumulating any wealth. He’s got all the fancy stuff, but he pushes himself further in debt month after month to maintain his lifestyle. If Fred were to get a big raise or bonus, he would just go out and buy another toy on credit, and never really build any wealth.

See, being income statement rich comes down to having the appearance of being wealthy, when in fact it’s far from the truth. The only person Fred is kidding is himself. He can’t sleep at night nor enjoy anything he has because he worries how he can make his next payment on the extravagant lifestyle he’s grown accustomed to. He’s at risk of defaulting on his loan if he were to lose his job for some reason. He’s got no plan for his future and is living a temporary life of fashion and comfort. Bill on the other hand, could survive without a problem for a year or two if he were to lose his job, because he has accumulated wealth and owns his property. He’s not as dependent on his monthly income to pay his bills as Fred is.

It doesn’t matter how much money Fred will ever make, he will always be broke and never own a thing. It comes down to managing your money properly, not how much money you make. Take the time to create a plan for yourself and build true wealth. Strive to own the things you need to survive, don’t allow those things to own you. It’s time to stop thinking you’ve got to impress anyone, or that more money will solve your problems, you must manage the money you take in properly.

The frugal negotiator can save tons of money (and make much more)

Too many people only think of negotiating for the best price when they’re buying a car, however, there are many other products and services that you pay for that you probably didn’t know you can negotiate the price on. It’s quite ironic how much time “frugal” people are willing to spend in clipping coupons, comparing prices, researching deals, waiting and watching, but they still never truly get the best deal they can – because they don’t ask for it. Many people are just uncomfortable when it comes to negotiating and thus leave significant savings on the table, or give their money away because they fear confrontation.

Most people would be surprised as to how easy it really is to negotiate and how large an impact they could make on their finances by simply asking for a better price. Below, I will list a number of items that you probably didn’t think you could negotiate a better price on, as well as provide you some tips to overcoming your negotiating fears.

Here’s a list of products or services you can potentially save a bunch of money on by simply negotiating:

• College Tuition – Got more than one kid that will attend the same private high school or college? Have a financial hardship? Just ask and see what they can do to lower your cost.
• Clothing – Retailers have significant mark-up in their pricing and managers do have the ability to offer discounts if you ask. Look for flaws in the items being purchased and use those to your advantage in discounting the item you want.
• Mattresses (beds) – Significant markups and dirty sales tactics lead you to believe that there’s little margin for these guys in their pricing. The fact is, if you’re paying more than half of the retail price, you’re probably throwing away money. Check out this guide to buying mattresses to save a bunch of loot!
• Hotels - You can save tons of money by haggling. Check out this site for more info and confessions from a hotel GM.
• Cosmetic Surgery- Negotiate before hand and save money!
  
• Cable - You’ve been loyal and they want to keep you – what are they going to do to keep you? Just ask!
• Groceries – You’re a loyal customer who comes back time and time again, ask and you shall receive.
• Mortgage Rates - Even if you’re upside down with a second mortgage, you can negotiate with your primary lender to drop the rates or you’ll look elsewhere to refinance your first loan. Here’s a great article on doing so.
• Home purchases – In markets like these, you can definitely low ball offers and make out like a bandit. Here’s some info to help you.
• Airline tickets – This Forbes article recommends going through an agent and haggling the lower prices than you can find online, because the agent may have more flexibility.
• Parking tickets and Traffic Tickets – You can negotiate your fines with local municipalities to often surprising results.
• Income Taxes – The IRS would rather have some money than none. Speak to an IRS rep and see what they can do for you, even if it’s simple a lower cost payment plan than racking up debt on credit cards you otherwise wouldn’t have to.
• Medical Bills – There is still flexibility even if your insurance company has already secured a lowered price. Call the doctors medical biller and see what they can do for you.
• Gap Insurance - If you must buy Gap through a dealer, ask for their lowest price. Compare it to the local credit union and ask them to match. If they can’t walk away.
  
• Car Insurance – Talk to your agent and see what discounts you can qualify for. Compare companies and try and combine all insurance policies through one company for significant savings.
• Vacation time – Don’t settle for the standard time offered. Most companies that tell you that they’re not flexible truly are. Sell yourself.
• Salary – It’s important to not focus on salary or vacation until they want you. Employers will do more things for people they want.
• Garage Sales – Everything can be haggled if you’re willing to walk away.
• Craigslist items and services – You should never pay full price for something on Craigslist.
• Haircuts and beauty supplies -  Don’t be afraid to ask for price matching. Stylists rarely care and in fact many like it because it leaves the customer more money to tip them.
• Jewelry - Same ole same ole… here’s a cool guide to help you.
• Cell Phone Plans and cell phones – wait to negotiate until your contract is up for the most bargaining power.
• Professional services like Lawyers, Accountants, Plumbers, Carpenters, etc.. – Negotiate prior to receiving service but keep in mind that if you cut too deep it could affect your service level.

You hate negotiating and or it makes you uncomfortable? Doesn’t it make you more uncomfortable to realize you’re not getting the best deal you can?

When it comes to overcoming your negotiation fears, you must change your buying perspective.

You feel like you’re screwing them over? It truly comes down to your understanding that by your striking a deal, both parties will still come out as winners. If you go and buy something and don’t negotiate, you’re ripping yourself off. If you simply leave them without giving them a chance to lower their price, you’re hurting them. Give them a chance to compete, a sale with low margin is still better than no sale at all.

You spend all that time being a frugal person, yet you don’t take the final steps to realize complete frugality. It doesn’t make sense to spend hours on research and price comparison to save 10% and then leave another 10% or more in potential discounts on the table because you can’t spend another couple of minutes trying to get the best price.

It may take you a few times negotiating before you hone your skills and start to feel comfortable. Here is another resource on different and effective negotiation skills I recommend you read when you get a chance, with an emphasis on the art of persuasion.

Several of the items above were featured on an old article over at Forbes.

Reader Questions: Biweekly mortgage payments and cutting years off of my loan

As my site expands and my readership grows, I will try and answer more specific questions for my readers and create a FAQ section on the site for readers to thumb through if interested. Please, submit your questions to me as well, I will answer them as quick as possible.

Today’s question comes from a friend and a reader Ryan K:

“My mortgage company called me and asked me if I would be interested in signing up for a biweekly mortgage payment plan, they’re telling me I can save thousands in interest and cut years off the life of my loan – what’s the deal, is this something I should look into further?”

First off, Ryan (and my other readers), be wary of any products being “offered” by your mortgage broker that claim to save you thousands of dollars. Quite often, you can accomplish the same thing by simply calling your bank and asking them. In doing this, you can avoid unnecessary fees and other charges that would go right to the mortgage broker for something offered free by your bank. Also, as the old mantra goes “If it sounds too good to be true, it probably is.”

To answer the question though, what they’re telling you with regards to saving money and cutting years off of the life of your loan is quite misleading. They want to make you think that you’re payments will be the same in total and that the frequency of your payments will create savings and lower the life of the loan and associated interest charges. It’s just not true.

Let’s use an example of a mortgage payment of $1000 due every month. If paid as usual, you would pay $12,000 at the end of the year. In going to a bi-weekly payment plan (making a payment every two weeks) rather than making 12 payments per year of $1000, you will be making 26 payments of $500. You will pay off the loan faster because you’re paying more on your loan each year. Instead of having paid $12,000, you will have paid $13,000 at the end of the year.

There’s no question you can save money in the form of interest charges as well as increase your taxable deductions, but you will have to come up with the additional $1,000 per year in mortgage payments to do so.

You can accomplish the same task for free by sending your mortgage payment along with an additional payment to be applied towards principal (make sure your lender allows this, and that you don’t have prepayment penalties).

I caution you to make certain you can make the additional payments if you decide to move to a biweekly payment plan, as you will pay more throughout the year. If you can do it, yes, it’s great. But you’re not saving money by paying more frequently, rather by paying more on the loan period.

What’s your question?

Are you prepared for an earthquake or natural disaster?

Seeing the recent destruction and annihilation in Haiti, Chile, and now Taiwan, it makes sense to review your own disaster preparedness plans. In St. Louis, we’re only 150 or so miles away from a huge fault line ( the New Madrid Fault Line), and honestly, anything could happen at any time. The last time something major happened was about 110 years ago. Before that, about 200 years ago, a major quake on the fault caused the Mississippi to flow backwards, and created Reelfoot lake in TN.

So what can or should we do to ensure we can survive until we can get out of town and or until help arrives? What types of supplies should we have on hand and how can you incorporate this into your everyday living plans so you don’t just do this for a year or two?

• What to do before an earthquake (FEMA)
• What do to during an earthquake (FEMA)
• What to do after an earthquake (FEMA)
• Seven Steps to Earthquake Safety
• Preparedness FAQs

More links to earthquake preparedness information and response agencies

How much rent or house payment can you afford and still live comfortably?

You must decide between a couple of places, the cost is only a couple of hundred different a month and one place is so much bigger. Should you spend the extra money for the extra space or not? Will you end up putting yourself into a bind down the road if you face unexpected bills? This is often a question faced by many people who are moving out on their own for their first time and or buying their first home. Banks have guidelines as to how much money they would be willing to lend you based upon your current earning power and other criteria, but as we’ve seen that hasn’t worked out so well for the banks and many borrowers. Along the same lines, some renters are required to pass certain criteria to qualify for renting. Predatory lending and variable ARMs on loans were partly the culprit for the current economic crisis, and banks sacrificed short term profits at the expense of long term sustainability, but we’ll save that talk for another day, it will get us nowhere fast.

So how much money should you spend when looking at housing or when deciding which apartment to rent? Below, I will make it easier for you to devise a smart plan for yourself, so you don’t have to count on someone else telling you a magical debt to income ratio you should abide by.

Step 1: Determine how much money you take home after taxes.

This should be a fairly easy task, how much money are you taking home, not grossing? Look at your paycheck and sum all paychecks for the month. Take into account how often you’re paid. Some months there will be four weeks, while others there will be five. If you’re paid monthly, you know you will be paid the same amount. Some folks are paid bi-monthly, and it works out the same way. However, those folks paid weekly may have fluctuations in their monthly take home pay and should take this into consideration.

Step 2: Calculate your monthly expenditures that are not housing or utility related.

Calculate how much money you will spend on a monthly basis on items such as food, gas to get to work, bus or taxi fare, clothes, car insurance, renters insurance, cell phone, and so on. If you’ve got credit card bills and other bills include these here too. Don’t forget about spending money for entertainment either.

Step 3: Calculate your monthly expenditure related to housing and utilities for each of your new options.

While non housing goods are probably going to be fairly stable (with the exception of gasoline), you must calculate how much your utilities will cost for each option. Ask the current owners or renters or landlords what the bills for each place run each month. A place twice as big will likely cost twice to heat and cool, while water maybe constant. Don’t forget about cable, internet, trash, and other utilities like your phone.

Step 4: Determine how much money you should be saving and investing.

You must pay yourself and save and invest in your future. If you’re not calculating saving at least 10% of your pay (and have an emergency fund equal to living expenses for how long it will take you to find a job if you lose yours – you’re setting yourself up for failure otherwise) you are saying you don’t care about your own future, and want to work for the rest of your life for money, instead of having money work for you.

Step 5: Combine the numbers and see which option makes cents.

Here’s an example of a 22 year old kid (we’ll call him Freddy) that makes $30,000 per year, paid weekly, and he’s planning on moving out of his parents house at the end of December.

Freddy’s After Tax Pay = $462 per week. ($30,000 less 20% taxes = $24,000 per year after tax, you can calculate this by taking $30,000 times .8 or $30,000 times .2 = $6,000, then take $30,000 less $6,000 = $24,000) ($24,000 divided by 52 weeks = $462 per week).

This means in January, a five week month, Freddy takes home about $2310. While in February, Freddy only takes in $1848. It’s important to take this into account as you can see it’s a big difference.

Let’s look at those two months, Jan. and Feb.:

Freddy is considering renting two different places Option A and Option B, one Option A costs $750 per month, and Option B costs $1000 but is twice the size. He really wants the second place but is not sure he can afford it or not.

For Jan. and Feb Freddy estimates the two different options to determine what makes sense:

Clearly, you can see why it’s important to do this type of analysis. You don’t know what is the best option until you crunch the numbers. It wouldn’t make sense to take on more than you can afford in option B. Freddy wouldn’t be able to cover his bills more less savings goals in February with option B, even though he could it in Jan.

In general, it doesn’t make sense to back yourself into having 0 dollars left over at month end. What if your car breaks down and or you have to buy a gift for someone. I would suggest you leave an additional cushion of around 10% to cover unexpected costs that may come up. After you’ve gotten comfortable doing this for a year or two and you’re certain you can manage your finances properly you can take more risk in leaving a cushion, perhaps by then you will have built a couple of emergency funds to cover potential unemployment and or other financial emergencies like car repairs.

Hope this helps!